Euro area, United Kingdom

Our economic and market outlook at midyear 2023

June 26, 2023

The euro area economy contracted in the fourth quarter of 2022 and the first quarter of 2023. We expect growth to resume but the expansion to be short-lived. A new downturn is likely to arrive this year or next. In the United Kingdom, marginal growth has continued, but there, too, we anticipate recession, as well as higher rates of inflation than on the continent. 

The inflation fight proceeds, slowly

Jumana Saleheen midyear VEMO 2023 video

Video length: 2:48

Euro area

Our outlook for year-end 2023


Economic growth,

We believe the energy crisis drove the shallow 2022–2023 contraction. A muted recovery is likely before the lagged effects of monetary policy tightening trigger a new downturn. The peak impact of European Central Bank (ECB) interest rate hikes will occur in the second half of 2023, lowering output.


Core inflation, year-over-year

By any measure, inflation has declined meaningfully. Falling energy prices should help the headline inflation rate to further ease in coming months. Food prices are past their peak, too. Neither are included in the trend-revealing core rate. Service-price inflation, linked to wage growth, is stickier and central to our expectation that core inflation will end 2023 at 3.3%, still well above the ECB’s 2% target.  


Monetary policy rate

The ECB has hiked interest rates by 400 basis points (4 percentage points) in 12 months. We expect one or two additional increases. A deposit rate of 3.75%–4% would represent a restrictive policy stance.* It would exceed our inflation forecast and be more than twice our 1.5%–2% estimate of the region’s neutral rate of interest, a theoretical rate that neither stimulates nor inhibits growth.


Unemployment rate

After peaking in 2020 at 8.6% amid the COVID-19 pandemic, the unemployment rate eased to 6.5% in April 2023. We foresee a partial retracement in the second half of 2023 as the ECB’s inflation-fighting campaign passes the one-year mark and the lagged effects of changes in monetary policy are fully revealed.

What Im watching

Euro area wage growth likely to peak at year-end 2023

“More than half the rise in euro area inflation in 2021 and 2022 owed to corporate profit growth. We expect workers’ pay to play a bigger role in setting the rate of inflation in the coming months. Even so, year-over-year wage growth is likely to decline sharply in 2024 amid declining inflation expectations and weakness in the labor market.”

Shaan Raithatha

Shaan Raithatha,
Vanguard Senior Economist

A chart shows euro area wage growth on a quarterly basis from 2009 through 2022 and Vanguard forecasts for 2023 through 2027. Also shown as three components of wage growth: inflation expectations, the net demand for labor, and productivity gains. Across all quarters, inflation expectations drive wage growth, accounting for perhaps 75% of the year-over-year changes, on average. Productivity gains are the next biggest factor, accounting for roughly 15% to 20% of wage-growth changes. Net demand for labor is the smallest driver of changes in wages, accounting for roughly 5% to 10%. Our forecast is for wage growth to peak a bit above 4% at year-end 2023 and to drop sharply in 2024 to about 2% at year-end. We expect wage growth to then rebound and average about 2.5% in 2026 and 2027.

Notes: Proprietary Vanguard forecasts of euro area wage growth from the beginning of 2023 to the end of 2027 are based on quarterly government-reported data from the second quarter of 2009 through the fourth quarter of 2022. Data reflect year-over-year changes. Net demand for labor reflects gross demand for labor minus supply of labor. Positive net demand boosts wages and vice versa.

Sources: Vanguard calculations, based on data from Eurostat and Bloomberg.

United Kingdom

Our outlook for year-end 2023


Economic growth, 

As in other markets, we’ve been surprised by the resilience of the U.K. economy. Our initial forecast of a 2023 contraction in the production of goods and services has given way to an estimate of no change in output. As elsewhere, we believe a recession remains more likely than a soft landing.  


Core inflation, year-over-year

Strengthening services inflation has driven core inflation to more than 30-year highs, whereas core inflation is retreating in many other developed markets. We expect core services inflation to drive broader headline inflation in the year ahead as prices for food, energy, and other goods wane.


Monetary policy rate

We’ve recently raised our forecast for the Bank of England’s terminal rate by three-quarters of a percentage point given stronger-than-expected inflation data, the continued tight labor market and accelerating wage growth. We maintain our view of no rate cuts until mid-2024 at the earliest.


Unemployment rate

By a variety of measures, notably rates of employment and wage growth, the labor market displayed strength in the opening months of 2023. Yet consumers have not been confident about future employment. We expect a modest rise in unemployment in the second half of the year. 

What Im watching

Stubborn core inflation

“Over the last two months, core inflation has accelerated, in stark contrast to the euro area and the United States, where rates appear to have peaked. Particularly concerning is that core pressures seem to be driven by strengthening services inflation. With the labor market still tight, the Bank of England likely has some hard work still to do to guide inflation back toward its 2% target.” 

Shaan Raithatha

Shaan Raithatha,
Vanguard Senior Economist

Accelerating core inflation

Core inflation has accelerated in the United Kingdom, the euro area, and the United States during the economic recovery in the years after the COVID-19 pandemic began. Although it has started to fall in the euro area and the United States in 2023, it continues to rise in the United Kingdom.

Notes: Chart shows changes in the core consumer price index for all locations.

Sources: Vanguard calculations, using data as of June 21, 2023, from the U.S. Bureau of Labor Statistics, Eurostat, and the U.K. Office for National Statistics.

The outlook for emerging markets

The challenges facing the euro area and the United Kingdom are magnified in developing Europe. We expect growth of around 1% in 2023 and just below that level in 2024 in the greater Central Europe and Africa regions and core inflation to remain in double digits.

* The deposit rate is the annualized rate of interest paid by the ECB on banks’ overnight deposits. 

Notes: All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future results.

A closer look

Joe Davis

Our midyear 2023 outlook

Restrictive monetary policy will weigh on global economies.

Map of the Americas


Resilient economies are ultimately likely to face the prospect of recession.

Map of Asia Pacific


China’s and Australia’s economies share one attribute: Growth slowdowns are likely.

Abstract of balls leading into a circle

10-year asset-class returns

Our 10-year annualized return forecasts are modestly lower since the start of the year for most developed markets.

Abstract of balls separated by ribbon

Inflation and portfolios

Even in the unlikely event of long-term elevated inflation, a 60/40 portfolio could serve investors well.